Sun Life Financial Inc (SLF) 2004 Q3 法說會逐字稿

I’ll start by introducing the members of the management team present for today’s call. Hosting the call we have Don Stewart, Chief Executive Officer of Sun Life Financial; Jim Prieur, President and Chief Operating Officer; and Paul Derksen, Executive Vice President and Chief Financial Officer.

Also available to answer questions we have Kevin Dougherty, President Sun Life Financial Canada; Bob Salipante, President Sun Lite Financial US; and Rob Manning, President and CEO of MFS. Ron Friesen, Vice President of Corporate Capital will also be speaking on the proposed capital restructuring.

The slides to which the speakers will be referring are available on the Sun Life Financial website. Turning to slide two, I would draw your attention to the cautionary language regarding forward-looking statements, which form part of this afternoon’s remarks. This slide reviews the reasons why forward-looking statements could be rendered inaccurate by subsequent events.

And with that, I’ll now turn things over to Don Stewart.

Thank you, Tom, and good afternoon. The third quarter of 2004 was another solid quarter of earnings for Sun Life Financial. Operating earnings were 439 million in the quarter, up 11 percent from the same period a year ago. Earnings per share of 73 cents are up 12 percent from 65 cents per share one year ago. Return on equity at 11.9 percent was up from 11.3 percent in the third quarter of 2003.

Of particular note, these results have been achieved in spite of the significant depreciation of the Canadian dollar against the US dollar. In addition, persistent low interest rates and an equity market that has been trending sideways for some time, make the results this quarter all the more satisfying.

The operating results in several business units throughout Sun Life Financial are worthy of specific mention. In Group Retirement Services in Canada, where we have established clear market leadership, the latest industry statistics confirm that Sun Life Financial enjoyed a 47 percent market share of total pension sales and 58 percent of defined contribution sales in the first half of 2004.

In the United States, the multi-point annuity continued its strong performance as the number two selling equity indexed annuity in the entire US market, as we expand our presence in this profitable market segment. Also in the US, the expansion of our group insurance distribution from 20 to 24 offices in the quarter contributed to a 26 percent increase in group sales from the same period a year ago and business in force was up 12 percent in the period.

In Asia, sales were up 79 percent on a year to date basis. Life insurance sales in India were up a very impressive 170 percent in local currency, over the third quarter of 2003.

At MFS, we continued to experience net outflows during the quarter as a whole. However, during September, net sales across the complex were essentially flat, with positive institutional flows offsetting net redemptions in mutual funds. We’ve been encouraged by indications that the institutional market has endorsed the reforms put in place at MFS to increase transparency and strengthen governance.

In August and September, institutional flows were positive and in October we were awarded a $500 million US mandate, which had earlier been put on hold pending resolution of regulatory issues. The focus going forward continues to be on improving investment performance and the indications there are also positive. Performance in fixed income and international funds continues to be well above median. We seek to return to positive sales in domestic retail mutual funds, as we deliver continued improvement in domestic equity performance.

Capital management is an ongoing focus for Sun Life Financial. On top of the 29 percent year to date dividend increase last quarter, we have continued to buy back shares in Q3. In this quarter we repurchased 3.4 million shares at a cost of $124 million CAD, for a total of 5.1 million shares repurchased year to date.

Earlier today the Board of Directors approved a plan to reorganize the holding of Sun Life Financial Inc. to optimize the benefit of new holding company rules introduced by the Office of the Superintendent of Financial Institutions, subject of course to regulatory approval. Paul Derksen will speak in more detail to this in a moment.

Before I hand over to Paul, I want to address an issue that has been weighing heavily on the insurance industry for a few weeks. There has been considerable attention paid in the media to investigations by regulators concerning the insurance industry’s compensation disclosure practices, as well as the market distorting activities of certain brokers and insurers. The descriptions of market distorting activities are very troubling and have no place in our industry. We know of no instance in which Sun Life Financial has engaged in such activities.

As for the more general issues surrounding broker compensation, the interest of our customers are paramount. I want to express to them our continuing commitment to adhere to the highest business standards. Sun Life Financial is committed to best practices on governance and transparency for our investors and customers. We believe that our existing commission and business practices are appropriate, but also recognize that the regulatory landscape in this arena is evolving rapidly.

In the light of the recent development, we are reviewing our commission and related business practices to ensure they comply with all applicable legislation and meet rigorous standards of conduct and disclosure. We accept and welcome a higher degree of scrutiny. We will be an active participant in discussions that will take place among the regulators, our industry and clients, about the issue of compensation disclosure and we support the concept of greater transparency around broker compensation.

I will now hand over to Paul Derksen for a detailed review of our performance over the quarter. Paul?

Thank you, Don. I will turn to slide number four. We had, as Don mentioned, very strong earnings growth this quarter. Earnings per share were up 12 percent from a year ago. For the first nine-months our earnings per share is up 20 percent, which is despite the strengthening of the Canadian dollar, which has cost us approximately 5 cents so far this year.

Third quarter earnings were the same as in the second quarter of ’04 as the currency and equity markets cost us approximately 2 cents this quarter.

Slide five shows how our earnings have been trending positively over the last year. They’re up 11 percent for the quarter and up 18 percent for the year so far. Similarly, return on equity has been trending positively. Return on equity is up 60 basis points year over year. The current quarter was off slightly from the second quarter, mainly due to the strength of the Canadian currency.

Exchange reduced our return on equity by 10 basis points relative to the third quarter of ’03 and a higher currency year to date cost us about 30 basis points. At this time we should probably mention the special items we had this quarter, which are reflected in the corporate section of the MD&A.

I’m quite pleased to report that we had a very favorable settlement with tax authorities that enabled us to reduce our tax charge by $95 million. At the same time we increased our reserves by 80 million and expensed the cost associated with the earlier redemption of debentures, which is about 12 million.

Turning then to the business groups, on slide number six, Canada had a very good quarter with earnings at 242 million, up 17 percent from a year ago. Items driving the earnings increase over the third quarter of ’03 include better equity markets, better experience in group benefits and of course, CI mutual funds. ROE was up 140 basis points from the third quarter in ’03.

Slide seven; individual wealth and good sales results have premiums and deposits up 21 percent. Both annuities and mutual funds improved. Sun Life sales represented 46 percent of total CI net sales in the third quarter. Wealth sales were down slightly from the second quarter, mostly because of seasonality. Individual life and health sales were down from the second quarter, which included a sales campaign and were the same as in the third quarter of ’03.

Sun Life has introduced a repriced UL product in October, which is expected to contribute to top line growth in the ensuing quarters.

On slide eight, Group Retirement Services, as Don pointed out, is having a banner year. GRS accounted for 58 percent of the DC plan sales and 47 percent of the total pension sales so far in ’04. Sales are up 52 percent for the quarter and 171 percent year to date. DC assets are up 14 percent year over year. We look forward towards continued growth from this part of the business.

Group benefits, on slide nine, were up 8 percent from the second quarter of ’04, due to growth both in insured and the ASO health lines. Sales were down slightly from the third quarter of ’03 on lower life sales. Business in-force, an important indicator, is up 6 percent year over year.

Turning then to the United States, on slide 10, US dollar earnings are up 49 percent for the first nine months of this year, but flat for the quarter. The effect of improving spread and credit experience was reduced by some reserve strengthening in the third quarter. Earnings are lower than the second quarter of ’04 because of unfavorable group claims experienced in the third quarter and because the second quarter benefited from the implementation of a hedging program.

Gross annuity sales, on slide 11, were up 30 percent from last year, with indexed annuities 5 times the level in 2003. The multi-point index product is the number two seller in the industry. With the launch of the new GMAB product and a strong new management team, we expect variable annuity sales to increase in the ensuing quarters as well.

Group life and health sales were up 26 percent year over year. Stronger group sales came from the expanded distribution channel. Sales were down from the second quarter of ’04 primarily for seasonal reasons. Business in-force, important indicator, was up 12 percent year over year, to $770 million.

Individual life sales were strong this quarter. Continued growth in UL sales as well as BOLI deposit increased individual sales by 65 percent compared to a year ago.

MFS earnings, on slide 13, were up from the second quarter, but slightly below the third quarter of ’03. The main reason for the decrease was higher expenses and lower revenues associated with the regulatory settlements. Compared to previous quarter, earnings were up to $2 million, mostly from reduced settlement-related costs.

On slide 14, assets under management. At $134 billion, assets were up 4 percent year over year, with the greatest growth in institutional assets. Assets were lower in the third quarter relative to the second quarter of ’04 and the following slide gives you some more details of the specifics of the flows. The net outflows, on slide 15, for the quarter were $2.5 billion, with mutual funds accounting for $2.2 billion. The redemption rate decreased to 25 percent from just above 34 percent in the second quarter and 28 percent in the third quarter. So this is a very positive development, this evolution in the redemption rate. Market movements reduced the asset balances by almost a billion this quarter.

The monthly trending is very important, and slide 16 points that out. When we do look at the monthly trend, net flows improved significantly in the third quarter, particularly in September and August, with institutional and annuity flows being positive both in August and September. It's obviously too soon to declare victory, but the trending is certainly encouraging.

On slide 17, MFS continues to be a very strong competitor in the US mutual fund market. They are number five in domestic equity, number four in international, number nine in tax free fixed income and number eight in taxable fixed income. Also, MFS has improved its market position and is now the 10th largest mutual fund in the United States, from 11 last quarter.

MFS has a very strong base to grow business from going forward.

In Asia, on slide 18, revenues were up 30 percent from a year ago in local currency, up 22 percent in the Canadian dollar. Earnings are up 29 percent year to date in local currency, as higher sales in conjunction with productivity improvement programs contributed. The stronger Canadian currency offset the operational performance I just talked to, to produce level earnings in Canadian dollars.

On slide 19, Asian sales expressed in annualized premiums are up 79 percent year over year, driven by strong growth in most of the countries. And you see them listed there; the Philippines is up 12 percent in local currency; Hong Kong 35; India 197 percent; China 39 percent; and Indonesia 179 percent.

The United Kingdom, on slide 20, had another good quarter with earnings of 17 million pounds, a return on equity of 21 percent. Resistency is around 89 percent. Revenue was down from a year ago, primarily due to the continued run off of the group life business, where the renewal rates were sold in the first quarter of ’03. Earnings were down 11 million pounds from a year ago, primarily because of favorable tax settlements in the third quarter of ’03.

Turning then to slide 21, on the left hand side you see non-MFS expenses were down from the second quarter, were up 3.7 percent from a year ago, as we continue to invest in customer service and productivity initiatives. The expense ratio reduced from the previous quarter.

On the right hand side you see MFS expenses. We were up significantly from 2003, but below the second quarter of ’04. The reasons for the increase were legal and compliance-related expenses as well as the elimination of certain soft dollars. We expect expenses to decrease over time, with margins improving gradually.

On slide 22, our asset quality is very strong. Gross impaired assets were reduced by $294 million from the third quarter, and by $10 million from the second quarter in ’04. The reduction is primarily due to the sale of impaired assets. Allowances decreased for the same reason, leaving us with a net impaired ratio of 22 basis points, which reflects the very positive credit strength of the portfolio.

Slide 23, MCCSR was 238 percent this quarter. It was actually a fraction of a percentage point off the previous quarter, entirely due to exchange. The debt to capital ratio remained at 20 percent.

We bought back $124 million worth of shares in the third quarter and $187 million year to date. We announced the redemption of $250 million of debt buyback and Ron Friesen will speak in a moment about the capital restructuring scheduled to take place in January of ’05.

That takes me then to my last slide, which is sources of earnings for the three months ended September. You can see the expected profit was down from last year. That’s entirely due to currency. We estimated currency or rates or established at the beginning of each period, and we’re comparing the June rate of $1.35, to $1.58 at the beginning of ’03.

New business stream is more or less the same as it was a year ago. Experienced gains – we had some positive experience gains; mortality, morbidity and other experience gains throughout the organization. The assumption change is a negative $59 million. It reflects the increases in reserves in the corporate area, which I referred to earlier.

Increase in investments and income in the surplus area and the impact of debt buyback increased the earnings on surplus. I’ve spoken to the taxes earlier, which leads you to the $439 million reported on earlier.

This concludes my portion of the presentation and Ron Friesen, Vice President of Capital will now give you an update on our capital restructuring.

Thank you, Paul, and good afternoon. As you are aware, OSFI has proposed to eliminate the minimum capital requirements for regulated insurance holding companies. In addition, foreign life insurance companies that meet the size test, which Sun Life US does, will not be consolidated for capital purposes at the holding company. Instead, investments in these foreign life companies will be backed out of the holding company’s total capital. This will allow Sun Life US to maintain its capital levels, based solely on US requirements under the NAIC rules, which are lower than the Canadian capital requirements for fixed annuities.

As Don Stewart mentioned earlier, Sun Life’s Insurance Financial’s board approved the reorganization of Sun Life’s assurance company to accommodate these changes. As you can see on slide 27, the reorganization will involve a separation of Sun Life’s insurance operations from its principle asset management operations.

After the reorganization, the shares of CI, McLean Budden, MFS and all of the US subsidiaries, including the US annuities company, will be owned by the Asset Management Company. Sun Life Assurance will continue to own substantially all of the life and health insurance businesses in Canada, the US, UK and Asia.

As you can see on slide 28, we believe that the reorganization will give us more flexibility to pursue strategic opportunities. For example, our new acquisitions by holding company will not be consolidated to Sun Life Assurance, which is subject to the minimum capital requirements. This will allow Sun Life to finance future acquisitions on a more efficient basis.

Although we have no immediate plans to make significant changes to the holding company’s capital structure, we believe that under the right circumstances, the new structure will allow us to access over a billion of capital by taking advantage of additional leverage capacity from the asset management operations. This will have a positive impact on our cost of capital and ROE.

The structure will also allow Sun Life US to compete with its US competitors on a more equal footing for the reasons I mentioned earlier. Our primary regulator, OSFI, have reviewed the reorganization in detail and have advised us that they are willing to make a positive recommendation for approval to the Superintendent of Financial Institutions. Our plan is to implement the new structure effective January 4th, 2005.

I will now hand the call back to Tom Reid.

Thank you, Ron. Operator, we’re now ready to start with the Q&A portion of our call. And I’d ask that you please poll the callers for questions.

James Bantis, Credit Suisse First Boston.

Two product-related question. One on the variable annuity market in the US, you talked about some changes that are going in that arena. Could you talk about what management changes, what’s going to be done differently in terms of regaining market share?

And secondly, regarding the UL repricing in Canada, could you give us a little bit more color there as well, particularly what’s the new IRR (ph) in the product and how do you stand relative to competitors in terms of pricing as well?

Okay, Jim, I’ll take the first part. Bob Salipante here. On the VA side in the US on September 7th we released the latest version of our Sun Life Financial Masters product, Secured Returns 2. I think it’s the most competitive product that we’ve had in the marketplace in say four years or so. It has a strong bear market and bull market feature for the client.

In terms of management changes, Kevin Hart has joined us to lead our variable annuity distribution organization. He’s a veteran of that sort of business, having come from Sun America. And Mary Fay has joined us from GE, among other organizations, to drive our annuity manufacturing business. So both have been in place this quarter.

It's Kevin Dougherty speaking in regards to the Canadian UL question. Thank you. What we’ve done here is we’ve made some pricing changes, but we’re not – our objective is not to get to a price leadership position. This will move us from about ninth to about third or fourth in terms of pricing in the market. We’ve done that through some product changes and some changing in the commission levels and we feel it will continue to meet our long-term hurdle rates.

James Keating, RBC Capital Markets.

If I could immediate follow-up with Kevin, just those long-term hurdle rates, if you could just remind us what those are? Also, I think for Paul, on the reserve strengthening and tax changes here, could you just describe where each of those are allocated from a business perspective? I think I understood it was corporate, corporate and I think corporate. I missed, however, what the 12 million pertains to and I apologize. Could I just ask you to explain that one again?

On the hurdle rates we have an objective to achieve a 15 percent return on equity on our products and most of our products are achieved to design that. And this product is no exception. With regards to the reserve increases – you asked about the $12 million?

Yes, Paul, and also the allocation and where the others are located?

Okay, let me explain it to you. As you know, we have $80 billion of actuarial reserves. Some of these reserves relate to corporate items, such as the discontinued reinsurance business, which sits in the corporate section if you like, and other corporate-type expenses. And we reviewed these reserves on a quarterly basis and concluded that they needed to be strengthened this particular quarter. And so hence, we increased them by $80 million.

The $12 million is basically the premium on the earlier redemptions of this debt that we are redeeming on November the 15th, I believe.

Okay, thank you. The tax is (indiscernible), okay. We don't have any distortions in the line of business?

No, the three items were all in the corporate section. The tax is also related to corporate-type assets.

John Reucassel, BMO Nesbitt Burns Research.

Thank you. The first question is for Bob Salipante. You’ve been active down there as far as getting your team in there. Are you still expecting to bring on some new people or do you have your team set now down there?

John, the team is fully set and we’ve got a full compliment of players on the field and I’m very excited about it. As I said in the last call, I found Sun Life to be an attractive destination for industry veterans.

Okay great, I just wanted to confirm that. And Paul, I’m just trying to understand the new rules from OSFI. I understand they were still debating whether to have you disclose this adjusted MCCSR. Maybe you could update us where that process is? I realize they’ve come down on figuring that out. Maybe you could just enlighten us where that process stands?

Yes, John. The discussions with OSFI continue. I don’t think they’ve landed on the specifics of the rules at this point in time. They’re evolving. But directionally we believe that the rules will end up in a position which will benefit us and hence the restructuring.

Okay, you must have made some assumption to come up with this billion dollars in incremental capital. Can you share those with us as far as where you expect this to land then?

The essence of this is that we will be able to increase our leverage of the organization going forward. And we believe that it will generate at least a billion dollars of capital under the right circumstances.

Maybe I’ll circle back on that, because I’m still confused where – because of the OSFI rules. The other question I had was – I’m just looking at interest rates here in Canada and in the US, and I’m just wondering about your in-force block of business. Are you worried, or should we be worried about any assumption changes you might have to make as for reinvestment risk there going forward, if rates stay this low? And if so, do you know when you’d have to take a look at that?

We review our reserves, John, on a quarterly basis, as you know, and we make adjustments that we see fit at that time. We don’t – if we think we have to make reserve changes, we have to make them that particular quarter. We can’t just postpone them. And so we’re quite comfortable with our reserves, given where the current rate scenario is.

Timothy Lazaris, Griffiths McBurney & Partners.

I’ve got two or three questions. I’ll just start with MFS first. I’m trying to get a handle on how we should look at MFS as a distinct entity in valuing it. And if you look at the earnings that it contributes, I think it probably undervalues the total franchise value of MFS, so I would look to cash flow. And I’m wondering is there any way for us to determine what the cash flow from that operation is on a quarterly basis? And said another way, is there a way to give us what the amortization expense or non-cash expenses are for MFS this quarter? That’s my first question.

And then my second question is, you mentioned that during an acquisition or with an acquisition under this new strategic arrangement, that goodwill would not be part of MCCSR, but it would clearly still be calculated in your return on equity. So does that mean that you’d have a bigger appetite for acquisitions or neutral?

With regards to MFS, I don’t have the cash flow numbers readily available here. I’m happy to provide them to you over time. I think the best way to think about MFS in terms of value is to look at their margins. They’re much lower now than the industry because of regulatory and restructuring type events and we hope these margins will increase over time. And maybe that’s the background against which to value MFS.

With regards to goodwill, from an accounting perspective, goodwill is goodwill. And return on equity has to be calculated to incorporate goodwill. And so this restructuring is not making any change to that.

Okay and if one of your people there could actually send me perhaps what that amortization expense was in the quarter by email or otherwise I’d appreciate that. And just lastly, Paul, in the past you’ve mentioned to use what the sensitivity to your earnings were to an increase in the S&P and I’m wondering if you still have that sensitivity available?

We’re talking about 9-10 cents for every 50 point movement in the S&P500.

Over a 12-month period?

Yes.

Tom MacKinnon, Scotia Capital.

I guess my question on the equity market sensitivity was just answered. But with respect to the proposed restructuring, the second bullet talks about over 1 billion incremental capital. I think that’s subject to leverage constraints. Is that – that’s just kind of leverage capacity giving sort of a rating agency formula. Even if you took it up to 30 percent, it’s maybe 1.5 billion. Are you saying that now you’ve got that number to 2.5 billion? What actually have you effectively done here? Have you freed up another billion in capital? This is still subject to rating agencies and whatever other constraints you want to put in here. And I always thought that goodwill was certainly deducted from tier one in recommended approach from OSFI, so I’m not sure how you’ve freed up a billion – freed up goodwill on that, unless you’ve got a new hybrid version of the proposed rules.

And then finally with respect to enabling you to compete with US competitors on more equal footing, maybe you can just share with us how you actually price your products? Don’t you sort of price them for the maximum whatever the local requirements are and some sort of target surplus formula, which would be a function of the MCCSR. I’m not sure how you can suddenly just say you’re going to be on equal footing with people by – have you changed your internal pricing standards then? A few questions in there.

Good questions there. So let me just try it out a little bit here and see if I can cover some of those. For starters, on the rating agencies, we’re expecting a press release from those rating agencies by tomorrow, so you'll get into fine detail what their perspective is. But generally the notion is that we believe we can – the circumstances are – it’s all very dependent on circumstances. But generally we think we can increase our leverage of the operation as a result of this restructuring.

Did you give us something for your debt to total – your debt to total capital, what do you think you can increase that to and how much should we try to take a haircut for goodwill? Or should we just wait until this release comes out tomorrow?

The release will have more detail, but I’m not sure it has this sort of detail. Ron, can you answer the question?

Let me just clarify the comment on goodwill. As you know, the holding company capital proposals, there’s a no minimum capital at the holding company. So if you do acquisitions at the holding company, there is no minimum capital. Whether you have to deduct goodwill from tier one or total capital, it then becomes less of an issue from a regulatory capital perspective.

I’m still not sure how you get the billion freed up unless you make your acquisition then?

Well you can basically increase your leverage--.

I understand that. You always had that capacity in the past though. I’m assuming you always had the capacity to do that in the past.

Well no, the constraint here – the rating agencies look at it differently. Each rating agency looks at it differently. But this restructuring will enable us to have more leverage, which we would not have before.

Are we saying that this is a proposal that you’ve presented to rating agencies and irrespective of the OSFI requirements?

No, that’s not at all the case. We could not have done this transaction before the OSFI rules were available. We have looked at doing this on a number of occasions in the past, before I was here in 2000 and after I was here as well. And for a variety of reasons, which include regulatory, tax, multitude of reasons, we could not do this before. But with the OSFI changes that has really facilitated the process.

Okay, let’s keep it offline then, because rating agencies just kind of see through all of these things regardless and I’m just trying to get a handle as to – are you saying that your excess leverage capacity is now 2.5 billion? If I was able to calculate something at 1.5 billion, you’re at 2.5 billion now?

Tom, we’ll have to spend a little bit of time with you on this and tomorrow the rating agencies--.

This would be – is that a correct statement?

Tom, I just said we’re happy to spend a little bit of time with you at a later date. Tomorrow the rating agencies come up with their press releases, which provide a better basis for discussion.

Okay. What about the comment about the compete with US competitors on a more equal footing? Do you not price your products to hit some internal target surplus formula and have you actually changed that now?

Well there clearly are three considerations with regards to price in US products. First of all you have our economic capital considerations. It has to meet an economic capital hurdle rate. And secondly MCCSR with a particular constraint. And then the local US constraints, NAIC, was a third set of constraints. The MCCSR constraint is now being removed from the US business. And so we can now compete--.

You’ve adjusted your own internal pricing target? You used to probably price your product to some function of an MCCSR and that’s been removed? Am I correct in that?

The MCCSR constraint on the pricing has been removed, absolutely.

So your internal target surplus formula has changed, is that correct?

Well, I just said we have three targets, one is an economic capital, one is the MCCSR and one is the local one (multiple speakers) combination of those three, you have to obviously work among those three and get the best scenario for us. And now that the MCCSR is gone, we believe we can compete more effectively with our US competitors.

I guess I – if you could just state – your internal target surplus formula for pricing has changed, has been reduced? Is that a fair statement?

Tom, it’s going to change when we do this in January. What we’re saying is that previously you had to set your capital – required capital based on the higher of MCCSR, NAIC--.

Well that’s an internal company decision. Have you changed your internal company decision?

Well, as I said to you – as Tom said to you, restructuring will take place January the 5th and in anticipation of that we are re-looking at our pricing in the US.

Okay. And then secondly, maybe back to – if we’re looking at some of your positions in variable annuity in particular, is your goal to be sort of a top-ten competitor at the end of the day and do you view this excess – this increased leverage capacity as an opportunity to perhaps make an acquisition in that arena?

Let me just say – Bob Salipante (indiscernible) speak to the changes in product line, the changes in management team that we’re making in the annuities and we expect that over a period of time these will drive up our market share and drive up our sales. Where all that will lead, we’ll be in a better position as the quarters roll forward. We’ve always said that we would look at acquisitions, but of course, acquisitions are not made to order and will arise on an opportunistic basis. But I think in the foreseeable future we’ll focus on organic growth.

So Tom, I know you’re full of questions. What we probably should do in the interest of giving other people a chance to ask questions, we’re happy to meet with you whenever that works for you to go through a little bit more detail.

All right.

Mario Mendonca, CIBC World Markets.

First sort of a basic kind of question. Paul, when you referred to the tax benefit, the 95 million, and you explained that those were sort of offset by the reserve increase of 80 million in the cost of retiring the debenture of 12 million, the 80 and the 12, are those pretax or after-tax?

They’re after-tax.

They are after tax – that’s good. Secondarily, going back to Tom’s question – and I’m certainly not going to beat a dead horse here, but in terms of the pricing, isn’t it fair to say that you don’t necessarily have to change your pricing in the US, but perhaps just make your fixed annuity product look a little bit more like Lincoln’s or a little more like Nationwide’s, and that in and of itself actually results in just less capital being allocated to the product?

Yes, indeed. There are certain products in the US that require less capital and as a result you can have product features and pricing and such that’s more competitive in the local environment. It's that simple.

I guess maybe as sort of a follow-up to that is, when you purchased IFMG and Keyport, where there changes that had to be made to the product design because it was owned by a Canadian insurance company? Say for example, shortening the duration of the product as opposed to changing the surrender charges? Were there changes of that nature that essentially made the product not very attractive, that you can now go back to and make it like Lincoln’s, for example?

I think the issue there is that under Canadian rules, the fixed annuity business attracted a lot of capital. I think we discussed that on prior calls. So we think this should give us the opportunity to have a little more of a level playing field in the US marketplace, in particular for that line of business.

Right. It's always been my understanding that, say Lincoln’s and Nationwide’s products, they’re not – they have fairly high surrender fees associated with them. But high surrender fees really don’t get you anywhere under Canadian GAAP, because Canadian GAAP – I’m sorry, Canadian statutory standards are more dependent on the duration of the product, but not so much the size of the surrender fee. And in the past, that caused Sun Life to have to adjust products to make them accommodating under Canadian GAAP. I guess the question is, will your products now look a lot like Lincoln’s and Nationwide’s?

It's Bob Wilson. The problem with Canadian statutory capital requirements – you’re quite right. The capital requirement was dependent upon the term of the interest rate, whether it had a surrender charge or did not have a surrender charge. We did not change Keyport’s products when we took Keyport over, from what they were before.

The issue is that the provisions in the actuarial liabilities for mismatch, which are required under Canadian GAAP, are then duplicated by very onerous capital requirements set by OSFI under the MCCSR return. When we do our economic analysis of the capital available, the capital required plus the reserves comes to an uneconomic level, particularly if you want to hold 185 or 200 percent MCCSR ratios.

Now with the proposed changes by OSFI, the Canadian requirement, which the capital on Keyport is 5 percent capital requirement at 100 percent on most of their product on top of rather onerous reserving requirements under Canadian, will be replaced by the RBC requirement on the same products, which if I remember correctly is approximately 1 percent of account value as opposed to 5. That will enable us to have a product which is more competitive. And when we calculate our modified MCCSR, which will not include Sun US on the same basis as today, our modified MCCSR will not be hurt by selling product in the US that meet US requirements.

And that’s another way of saying that even if you were to drop your pricing, by virtue of not having to allocate as much capital to it, you still get the same IRR.

Yes, that’s correct, Mario.

That part of the discussion I do understand. The part I didn’t understand as well on capital is the leverage discussion. Because it’s become my understanding that the rating agencies are in a sense becoming the de facto regulators. If OSFI is content to lower capital requirements, the rating agencies haven’t changed in any way. So I tend to agree with Tom’s comment that the leverage capacity has always been there. Unless of course something’s changed from a year ago to now.

And I do recognize of course that the rating agencies have taken the negative watch off. But is that really what’s changed, that there rating agencies become a little more content with Sun Life’s capital structure and operations and now that Clarick (ph) has been integrated and Keyport’s been integrated, is that really the change or is it so much this OSFI thing?

Well Mario, unfortunately I haven’t got a rating agency press release in front of me that I can speak to and if I did it wouldn’t be appropriate, because they’re going to issue it tomorrow. But your point is quite right, that the rating agencies, particularly if you want to maintain AA+ rating under the S&P rules for instance, are becoming a constraint. But I would tell you that I think they look – particularly S&P looks favorable upon this type of restructuring.

And so I’d say – I can’t really speak for S&P or Moody’s and they will be issuing their press release tomorrow. And so it’s probably best to read those and then have another discussion.

I think it’s appropriate to wait then. And one final question. If we remove corporate from the entire discussion and just look at your pretax earnings excluding corporate, the quarter doesn’t look – the growth year over year is sort of down about 3 percent. And I think it’s a fair thing to remove the corporate in a discussion of this nature, because that’s not really what drives this company’s earnings. The 3 percent earnings growth year over year, was there something maybe aside from currency and equity markets that caused this quarter to look a little bit softer in that respect? Because year to date, prior to this quarter, Sun Life’s earnings growth year to date was approaching 19 percent. And it just seems that this quarter there was something that changed.

Mario, there’s a lot of different ways to look at it, including corporate, excluding corporate. I would say that the 73 cents this quarter represents – give a few cents either way, a recurring set of earnings of the operation. We’ve had significant earnings growth this year, as you know, 20 percent that I mentioned year to date. And the trending is in tact, except that I’m a little bit worried about the continued strengthening of the Canadian dollar and the weakening of the equity markets going forward. So I would say we’re watching those obviously, but they will start having an impact on our earnings going forward. And it had some impact this quarter as well.

Michael Goldberg, Desjardins Securities

Right from the $93 million favorable tax resolution this quarter, could you tell us what were the justifications for the $80 million reserve strengthening? And maybe more specifically, the type of reserves that you actually did strengthen?

In terms of the tax reserving, the tax provision, it’s a matter of policy. The Company sets aside additional provisions for exposure to a variety of tax issues. A number of these issues got resolved for the tax authorities and they resolved it in the benefit that you saw this quarter in the corporate area. And so we’re quite pleased with how this worked out and it reflects the conservative nature of these reserves.

It's hard for me to get into detail on these matters, because I’m not sure that it’s in the organization’s best interest and therefore, I don't think it would be appropriate. With regards to the $80 million increase, you have seen on a quarterly basis from time to time that we strengthen or release reserves. That's based on a very diligent process that we go through every quarter. And asses the assumptions in the variety of reserves and adjust those. And $80 billion will make a tiny little assumption change, based on the patterns that you see outside your organization and you get a sizable impact on the bottom line. And that goes for the operations as well as for the corporate area an this quarter it was in the corporate area.

Right. My memory may not be exact, but I don’t think that last quarter there were any assumption changes of this magnitude. I don’t remember. So I guess what I’m getting at is what specific adjustment changes were made to – give me a couple of examples of the assumption changes that were made this quarter, that produced the $80 million reserve strengthening.

Michael, the items, as I said that were covered here are the discontinued reinsurance and corporate-type expenses. I don’t think it would be appropriate for me to go through every assumption change in that. Those were the areas that were covered by these assumption changes.

It's just that when you see these sort of offsetting numbers, perhaps unrelated, the impression that it leaves is that there’s reserve pocket being created that I guess you could look at as providing flexibility for the future. Is that the right way that we should be looking at it?

No, Michael. The way I’d look at it is that these things are independent events calculated separately and they coincidentally occurred in the same quarter.

Eric Berg, Lehman Brothers.

Paul, with respect to the reorganization, I’m hoping you can take a step back and for those of us perhaps who are not as intimate with all the archain aspects of the MCCSR and tier one – I mean, candidly, it’s been an extremely technical conversation, one of the most technical that I have heard in a conference call in a long time.

All I know is that after January 5th, Sun Life Financial – well today Sun Life Financial is in the insurance business and in the asset management business. After January 5th, you’re going to be in the insurance business and the asset management business, it will be the same people and yet somehow by doing things on paper – and I don’t mean to say it in a pejorative way, but it is a changes in legal structure, all sorts of wonderful things start happening – higher ROE, the company’s worth more, we can do more M&A and so on and so forth. Can you take a step back and sort of tell us conceptually why this is happening? I’m missing the big picture here. I don’t need you to get into the details of every bullet point on slide 28. I can do that with Tom. But I suspect many of us are kind of baffled as to why a corporate – what seems to be a paper transaction, produces all sorts of economic benefits, even though it’s going to be the same company on January 6th?

That’s a very good question, Eric. And let me try to give you some perspective on this.

If you could keep it as simple as you possibly can.

Right, I understand that. One of the ways to think about this is that OSFI has taken steps to level the playing field, to ensure that the Canadian competitors are more or less on the same level as the foreign competitors by removing the minimum capital requirements at the holding company level. And with this restructuring we’re simply positioning ourselves to do that.

In addition to that – and you know, again, you have to reach the rating agency. The unfortunate part is I wish we could get these rating agency letters out. And they’re not consistent. The rating agencies sometimes look at it from a different perspective. But they look at the diversity of cash flow. They look at the amount of earnings that are being generated by a regulated entity as opposed to a non-regulated entity, a multitude of factors which enable us to increase our leverage. And so while I would agree with you, from a consolidated perspective, you don’t see necessarily a gigantic change. The sources of those earnings and those flows are important to some of the agencies.

So, is the idea here that again, from a very big picture, high level point of view, that right now, SLA is sort of facing capital requirements in the existing regime that it will not face when you restructure and, therefore, it is an economic – I mean, is that kind of the idea?

Well, I think that again, it is more a rating agency type aspect. And Mario, I think commented on that before. The rating agencies from time to time look at that from a different perspective, as I said. Not all rating agencies look at it the same way, but some of them, you will see in the press release tomorrow, do actually think this is quite a different structure. So I would much prefer – and unfortunately, having read the press release and you haven’t, I find I’m sort of tied, I can’t really – our agreement is that I won’t speak to the press releases until they come out. But I’m happy to discuss that further. Once they come out we’ll have the same basis to look at it.

Eric, just one other point that we shouldn’t forget. That by moving the asset management company out from underneath the regulated insurance company and up to the holding company, their capital requirements are now going to be governed by what the holding company’s capital rules are and under the modified rules, as I think was explained earlier, Sun Life US, for example, will not be consolidated out to the top company and therefore, not subject to the Canadian MCCSR rules. And it can focus on local NAIC capital rules. And it will make a difference going forward.

If I could just ask one more question. I’m going to reference slide 15, please, on MFS. How does that slide, as far as the net new sales – what I see here – is the exhibit essentially communicating that with respect to your retail business – does this picture attempt to convey the idea that the amount of negative flows is shrinking? The next slide is very clear, but if I look at what’s happening on slide 15 in the column charts, which look at, in the same period of time, the retail and the institutional business, what is the message in your opinion that we should take away from this particular exhibit?

I think the message – this is Rob Manning – that we read a lot of your reports and you all focus on the retail side of the mutual fund flows at MFS, which is an important part of our business. But it represents less than half of our gross sales today. And so what we try to do is give you a complete picture of all the different businesses we have; our variable annuity business, our sub advised insurance company business, our institutional business, as well as retail and offshore. And what these pictures are attempting to do is to aggregate all of that information and show you what we look like on a net sales basis. And the picture at the bottom, slide 16 I guess it is, is really trying to show you that we think the worst is behind us and that the aggregate flows for the Company are improving, but we still have an issue with retail mutual fund flows being negative, which you all know.

Okay. So it looks like in the September quarter, just to finish up and I want to let others go on, so this will be my final question. It looks like in the September quarter on the retail side, the negative flows narrowed compared to the June quarter.

That is a very good statement, yes.

Brad Smith, Merrill Lynch.

Paul, I just have a quick question. Most of us probably just got off of a Great-West call where Ray McFeetors was talking about their recently acquired Universal Life business. In my view, what I heard was it was something that they were focusing on based on the fact that they felt that it was important to their distribution. I mean it almost sounded like it was a lost leader type situation to me. And yet I’m hearing you reiterate the 15 percent pricing target that you’re maintaining in your UL business. Can you help me at all reconcile those two different views? I know you’re not privy to the assumptions and the methods at Great-West, but it just seems to me quite diametrically opposed sort of views – 15 percent is pretty attractive a price for return. Is there something specific in the industry that you’ve noticed or your people have noticed that’s causing divergence like this in views?

Brad, I didn’t listen to the call you refer to, so I’m not sure exactly what he said. All I know is that all our businesses and our business lines in particular have a 15 percent ROE target. That doesn’t mean necessarily that each product set in itself has it, but that the product line aims for a 15 percent ROE. And there is a business plan that we have that brings the broader business line to that level over time, based on which we are pursuing the strategy.

I’m sorry, within the UL business are you saying that there are different products delivering different returns?

Well that channel will be able to provide us with a 15 percent return over time, we believe.

I’m sorry, which channel is that?

That’s the wholesale channel in Canada, which the UL will get distributed. And so we have a 15 percent target for the product set that will go to through the UL channel – through the wholesale channel.

What does that product set comprise?

What we’ll do is we’re in the process of – we haven’t launched all those products. We’re in the process of doing it and when we do it we’re happy to share that with you.

Timothy Lazaris, GMP Securities.

Thanks. I’ll try to be brief. When I read the OSFI last press release some time in the summer, it spoke to similar businesses and some capital treatment with respect to similar or same foreign businesses. And I think most of us took from that that that would imply that you’d get some better capital relief from acquisitions in life insurance. Is that still valid or was that a valid observation at least in that you would be able to sort of focus your attention on that? Because in the past, Don, you did speak a bit about spending money or looking at your next acquisitions South of the Border and I’m wondering if OSFI’s had an impact on your thoughts?

Tim, I’ll just speak to the OSFI capital rules. Basically what the proposals are, that at the holding company, if you have a foreign life company, you can back it out of the capital requirements. You don’t have to consolidate it up to the holding company, and you back out the investment. And that applies to any life company and the test is really the size of the company as opposed to anything else.

And Tim, it’s Don Stewart. Speaking to the acquisition point you made, very much looking at acquisitions on their economic merits as opposed to our particular situation, either now or prospectively. So we would be looking hard if the deal would make sense from a shareholder perspective, given the specific circumstances of the company at that point in time. So I would like to dispel any sort of notion that we’re being driven by our structure to do anything. We’re very much driven by the target and driven by the specifics of the proposed deal.

Don, is South of the Border still your focus though?

Very much so. The United States is the largest market in the world and we continue to look at situations there and we’ll continue to do so, obviously these depend on the right deal at the right price at the right time.

Operator, we’re over our time a little bit. I’m going to suggest that we take two more questions. If you could just give us the next one, please?

Steve Cawley, TD Newcrest.

Hey Rob, how were flows in October? The month is almost over.

We can’t tell you. But the trend that you see on that chart will not be – will not surprise you.

Okay. On page 16 of the statistical supplement, it talks of the provisions for credit losses. Very low again this quarter, 3 million. What were the level of recoveries this quarter?

No, there were no significant recoveries this quarter.

Okay. When I look at the banks, Paul, basically they talk about a PCL rate. And I know you being a former bank CFO are quite familiar with that. How should I look at this, I’ll call it PCL rate, and what would be something more normal?

Steve, I’m not sure how to – I’m trying to think very quickly how to equate this. I can’t think of a quick answer to your question here, to be honest with you. I look at our coverage ratio and our net impaired ratio, which are pretty low. And they all lead to the same conclusion, which is that our asset quality is very high.

And formations don’t look like they’re very high right now at all either. It seems pretty benign. So you feel comfortable with this level basically?

Oh absolutely. I think we’re well-reserved in our assets.

One final one maybe for Don. I roughly calculated your 238 MCCSR, you’ve got maybe $2 billion in excess capital and now it looks like you’re going to get an extra billion of excess capital freed up, because the rating agencies will be a little bit more, potentially, lax with your debt to cap. So let’s call it $3 billion in excess capital. You bought back 3 million shares in the quarter and if I jumped in my model maybe I could tell you, but I think that could be amongst the highest you’ve bought back. Is that true? The 3 million shares this quarter?

Why don’t I answer the question more generally. I think the determination of the precise amount of excess capital is very difficult to do from an external perspective, because we have a number of local capital requirements. We’ve engaged in, as Eric observed, significant detail in this call on the specifics of the restructuring.

But the fact remains that the determination of free capital over and above reasonable ongoing minimum in Sun Life Financial is very hard to do externally. We acknowledge that we do have excess capital of significance and that if we leverage going forward that will obviously increase. And we’ve always said that we would either apply the capital to increased dividends, buy back shares or do acquisitions that make sense for the shareholder, or a combination of all three, and have upped the dividend significantly as I pointed out in my opening and we will continue to look hard at our share buy back program going forward. And you would notice that it’s upticked significantly in the quarter. And our commitment is to deploy the capital to best shareholder value. I think I’ve probably said all that before. It's worth repeating in the context of your question.

Yes and at 36.50 I would sense a bit of restlessness perhaps amongst your shareholders that it’s undervalued, let’s say, relative to your other peers and for seemingly lack of acquisition opportunities, it seemed like a good investment on your part.

We have been quite active this quarter. We were very active last year as well, when the price was very low. You see us act when the value is low. Right now we’re in a quiet period and obviously we can’t act. But you know when the price is low we’ll be in the marketplace.

Michael Goldberg, Desjardins Securities.

I’m going to try this a little bit different way and it’s along the lines of things that have been asked in the past. But on a pro forma basis, what could be the available capital in SLA and there required capital in SLA? And also, what would be available and required for Sun Life US under RBC? And can we assume that all of the additional capital over and above what’s available for SLA or SLF US, is available either for expansion or unregulated activities?

Michael, I think Eric commented earlier in the call that this call has been extraordinarily technical relative to other calls before. And I don’t think I want to add to that level of technicality. I’d be delighted to sit down with you and go through those specifics whenever you make yourself available to do that.

Okay, that’s great.

Operator, I think that’s it for the question and answer period. So thank you very much. I’d like to thank all of our participants on the call today. If there are any additional questions we’ll be available after the call. And should you wish to listen to our rebroadcast, it will be available from the website shortly after 6:00 p.m. this evening.

I’d also remind the analysts and investors on the call that Sun Life Financial will be holding an investor day on November 16th in Toronto. For registration details, please call the IR hotline or check the Investor Relations page on our website at www.SunLife.com.

With that I’ll say thank you and goodnight.